Keep Your Counsel | Winston & Strawn Newsletter

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Volume 3, Issue 2

May 2016

In the May 2016 issue of Keep Your Counsel, Winston Asia Attorneys selected three topical issues happening in the region.

To start with, David Hall-Jones and Jasamine Yung discuss recent foreign-dispute related arbitration development that happened in China. Then, Daniel Tang and Ivy Liu examine the most popular strategies adopted by foreign investors to overcome the regulatory challenges of China Media Law.

In the China Antitrust/Competition arena, Jingwen Zhu focuses on MOFCOM’s publication of three new cases of merger notification filing failure.

David Hall-Jones

Managing Partner – Asia

Jasamine Yung

Trainee Solicitor

Recent Foreign-Dispute Related Arbitration Development in China

Under the People’s Republic of China’s (PRC or China) Interpretation on Several Issues Concerning the Law on the Application of Laws to Foreign-Related Civil Relations (2012 Interpretation), there is a distinction between domestic and foreign-related arbitration disputes. The 2012 Interpretation sets out the “domestic” rule, under which domestic disputes must be arbitrated in the PRC while foreign-related disputes may be arbitrated either within or outside the PRC. Disputes falling under this domestic rule typically involve Foreign Invested Enterprises (FIEs) incorporated in China and wholly foreign-owned enterprises (WFOEs), both considered as PRC domestic entities. The range of criteria to determine whether a dispute is foreign-related or not is wide and decisions are made on a case by case basis.

Cases in the PRC have demonstrated the courts’ pro-arbitration attitude towards foreign arbitral institutions administering disputes in China. This was exemplified in Longlide Packaging Co. Ltd v BP Agnati S.R.L. in 2013, where the Supreme People’s Court upheld the validity of a China-seated International Commerce Centre (ICC) arbitration clause and allowed foreign-related disputes to have a seat in PRC.

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Daniel Tang

Partner

Ivy Liu

Legal Manager

Investing in Chinese Media, Cultural Services & Entertainment Sectors: Challenges and Opportunities

In the wake of Apple Inc. shutting down its iBooks and iTunes Movies services in China, the suspension of DisneyLife, a video streaming service jointly offered by Disney and Alibaba, offers another glimpse at the regulatory challenges faced by foreign investors tapping into the People’s Republic of China’s (PRC) media, cultural services and entertainment sectors.

This article charts the regulatory landscape in this regard and examines the most popular strategies adopted by foreign investors to overcome the regulatory challenges.

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Jingwen Zhu

Partner

MOFCOM Publishes Three New Cases for Failing to File Merger Notification

On May 4, 2016, the Anti-Monopoly Bureau of the Ministry of Commerce (MOFCOM) of the People’s Republic of China (PRC) published three cases in which administrative penalties were imposed on three foreign companies and two Chinese companies for violations of the PRC Anti-Monopoly Law (AML) and the relevant regulations. These companies failed to file prior notification with MOFCOM for clearance before closing their transactions. The penalties levied ranged from RMB150,000 (approx. US$23,000) to RMB400,000 (approx. US$62,000) in these cases.

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David Hall-Jones

Managing Partner – Asia

Jasamine Yung

Trainee Solicitor

Recent Foreign-Dispute Related Arbitration Development in China

Introduction

Onshore and Offshore Arbitration Trends in China

In Siemens International Trading (Shanghai) Co., Ltd vs. Shanghai Golden Landmark Co., Ltd (2013) Hu Yi Zhong Min Ren (Wai Zhong) Zi No. 2 (Golden Landmark case), the Chinese Court held that the dispute was foreign-related although it involved two WFOEs incorporated in the Shanghai Free Trade Zone (Shanghai FTZ) that entered a sale of goods contract governed by PRC law and to be performed in China. The validity of the arbitration clause contained therein, which stated that the arbitration was to be conducted in Singapore, was challenged but the Court held that the dispute was foreign-related due to “other circumstances” being:

Although the parties were incorporated as WFOEs in the Shanghai FTZ, their purpose was aimed at facilitating foreign investment trade;
There was sufficient connection to foreign investors who provided the source of capital, ultimately held ownership interests and made business-decisions; and
The sale of goods contract was similar to that of an international one, whereby goods were being imported into the Shanghai FTZ, stored in bond and passed through PRC customs procedures.

The approach taken in the Golden Landmark case was the first instance where the PRC Courts were keen to recognize a wider spectrum of elements contributing to the foreign element of a dispute and enforce a foreign award despite both parties being PRC domestic entities. However, it remains unclear what “other circumstances” are to be accounted for and what their respective weight is to be as in Beijing Chaolaixinsheng Sports and Leisure Co., Ltd v Beijing Suowangzhixin Investment Consulting Co., Ltd (2013) Er Zhong Min Te Zi No. 10670, the PRC Courts refused to enforce a foreign award because it regarded the dispute between a South Korean owned FIE registered in Beijing and another China incorporated company as purely domestic based on the ground that both parties are domestic entities, the subject matter of the contract is in the PRC and the contract was concluded and performed in the PRC.

Major Asian Arbitral Institutions Open Representative Offices in the Shanghai FTZ

In line with the PRC Courts’ shift towards a pro-arbitration stance and the State Council’s announcement in April 2015 that it would “support the introduction of internationally renowned commercial dispute resolution institutions,” three of Asia’s most popular arbitral institutions, namely the Hong Kong International Arbitration Centre, the Singapore International Arbitration Centre and the International Chamber of Commerce, have set up representative offices in the Shanghai FTZ to promote international arbitration. Their plans notably include best practice sharing and professional training to judges located in rural areas, where Courts typically have less sophisticated understanding and experience in dealing with foreign-related disputes and the overall arbitral process.

Since 2012, there has been a sharp increase in arbitration work due to the surge of Chinese outbound investments, particularly in overseas construction project-related work and technology. As PRC companies tend to favor local arbitral institutions (e.g. the Chinese International Economic and Trade Arbitration Commission, the Shanghai International Arbitration Center and the Shenzhen Court of International Arbitration), the formal presence of these three foreign arbitral centers in the FTZ will both help build closer relationships with the local institutions and strengthen the ties with PRC-qualified lawyers and law firms.

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Daniel Tang

Partner

Ivy Liu

Legal Manager

Investing in Chinese Media, Cultural Services & Entertainment Sectors: Challenges and Opportunities

Introduction

Regulatory Framework and Principal Regulators

The media, cultural services and entertainment sectors are amongst the most closely guarded areas for foreign investments, as evidenced by the latest revisions to the PRC Foreign Investment Industry Guidance Catalogue (Guidance Catalogue), published in early 2015. Indeed, the online publication of digital content has been expressly added to the Guidance Catalogue’s “prohibited” category for the first time, whereas most of the pre-existing restrictions and prohibitions relating to these sectors have been kept intact.

The extensiveness of the investment barriers is best illustrated in the “negative list” entry requirement system for foreign investment that was subsequently published in April 2015. This pilot scheme applies only in the four free-trade zones of Tianjin, Shanghai, Fujian, and Guangdong, and it streamlines the “encouraged,” “restricted,” and “prohibited” categories under the Guidance Catalogue by a single list of businesses subject to foreign investment restrictions and qualification requirements. Out of the 119 restricted businesses listed, more than 20 are in the media, cultural services and entertainment sectors, including:

Internet publication of digital content;
Broadcasting, transmission, production, and operation of radio/TV programs;
News publication, radio/motion pictures/TV programs, and financial information;
Production, distribution, and screening of motion pictures; and
Culture and entertainment.

Within this framework, there are myriad regulations and rules that deal with specific areas and often impose additional requirements. For instance, the suspension of the iBooks, iTunes Movies, and DisneyLife services in China is, according to media reports, a direct result of the Internet Publication Services Administrative Regulations that came into effect on March 10, 2016. They impose pervasive control measures ranging from operator licensing to content requirements, personnel qualifications, and server location. Most importantly, they toughen up the former legislation’s prohibition of foreign direct investment by requiring any project cooperation between a licensed operator and foreign-invested entities in China or foreign entities/individuals to obtain approval from the central government body.

After a series of intergovernmental agency reshufflings, the principal regulators are now:

The State Administration of Press, Publication, Radio, Film and Television of the People’s Republic of China (SAPPRFT), which was created in 2013 by merging the General Administration of Press and Publication with the State Administration of Radio, Film and Television;
The Ministry of Industry and Information Technology (MIIT); and
The Ministry of Culture (MOC).

These three PRC authorities have overlapping and sometimes competing jurisdictions. Other than the example noted above related to the online publication of digital content, SAPPRFT and the MOC regulate in parallel the publishing and operation of online games in China.

Layering to Get Rid of the “Foreign-Invested” Label

Currently, the PRC foreign investment regime primarily focuses on the entity form established by foreign investors in China. The first-tier vehicles, whether equity/cooperative joint ventures or wholly foreign-owned enterprises, fall within the category of foreign-invested enterprises (FIE). The second-tier entities invested in by FIEs, often referred to as FIE-reinvested enterprises, are subject to a regime similar to what is applicable to FIEs. However, when an FIE-reinvested enterprise sets up subsidiaries in China, those third-tier entities fall outside of the foreign investment framework.

Based on documents publicly disclosed by listing applicants on the PRC stock exchanges, there are a number of ways this layering technique has been used to get around relevant foreign investment restrictions. We are also aware that these third-tier FIEs successfully obtained government permits and licenses that are beyond reach of FIEs.

VIE Structures

As with other sectors that are subject to foreign ownership restrictions, variable interest entity (VIE) structures are often used in the media and entertainment sectors so that foreign investors can, through extensive contractual arrangements, exercise de facto control over licensed operators without directly owning the equity interests in them, as well as obtain cash revenue from the licensed operators’ business activities. The online game business, however, is among the few that are subject to specific statutory restrictions against the use of a VIE structure.

In a scenario in which a PRC individual would hold equity interests in the licensed operators as the nominee shareholder, precautionary measures must be adopted to ensure that the contractual arrangements applicable to the nominee also bind his/her successors (in the event that the nominee passes away) and spouse (in the event of a divorce). On one hand, recent reports on arbitration awards in this context confirm that an arbitration agreement that binds the deceased nominee can be used to loop in the deceased’s successors for enforcement purposes. On the other hand, in the absence of a direct contractual relationship between the deceased’s spouse and the foreign investor or its affiliates, Chinese arbitration institutions are generally reluctant to join the spouse as a party to the arbitration for the foreign investor to enforce against the spouse, on the basis that the subject equity interest forms part of the married couple’s marital property, for which the spouse is jointly and severally liable.

CEPA Concessions

For certain restricted industries, qualified individuals and companies from Hong Kong and Macau can take advantage of the Closer Economic Partnership Arrangement (CEPA) entered between mainland China and, separately, Hong Kong and Macau. CEPA is a free-trade agreement that covers trade in goods, trade in services, and trade and investment facilitation. Since the conclusion of the principal agreement in 2003, 10 supplements have been separately agreed upon to accord preferential treatment to Hong Kong and Macau investors.

The latest is the Agreement on Trade in Services, a standalone subsidiary agreement that will be implemented on June 1, 2016. The new liberalization measures in the cultural services and entertainment sectors allow:

A Hong Kong service supplier to operate on a wholly owned or equity joint venture basis if it has set up more than 30 stores on the mainland for the sale of books, newspapers, and magazines of different brands and from different suppliers;
Hong Kong service suppliers to engage in the sale and service of amusement game equipment; and
The distribution in the PRC of Chinese-language motion pictures produced in Hong Kong and imported through the China Film Group Corporation by distributors possessing an Operation License for Film Distribution on a quota-free basis.

At present, only Hong Kong service suppliers are:

Eligible to engage in the online music business, while in practice the sector is not generally open to any foreign investors; and
Exempted from the minority shareholding restriction applicable to the printing business of “publications and other types of printing materials” and permitted to invest up to 70% in the relevant Sino-foreign joint ventures located in pilot areas with mainland counterparts.

To qualify as a Hong Kong service supplier, a Hong Kong entity will have to satisfy the applicable qualitative and quantitative requirements and obtain a Hong Kong service supplier certificate from the Hong Kong Trade and Industry Department.

Conclusion

With the Chinese economy transitioning into a consumer-driven phase and the rise of the Internet economy, the fast-growing media, cultural services and entertainment sectors will continue to lure investors to place heavy bets for handsome returns. Foreign investors in particular will have to overcome the regulatory restrictions to stay ahead of competitors.

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Jingwen Zhu

Partner

MOFCOM Publishes Three New Cases for Failing to File Merger Notification

The Rules

Under the AML, mergers, acquisitions, and other transactions that qualify as “concentrations” are subject to prior merger notification with MOFCOM before closing if the following turnover thresholds are met:

The combined global turnover in the previous financial year of all undertakings participating in the transaction exceeds RMB10 billion (approx. US$1.5 billion) and two of the undertakings’ individual turnovers in the PRC exceed RMB400 million (approx. US$62 million); or
The combined PRC turnover in the preceding financial year of all undertakings participating in the transaction exceeds RMB 2 billion (approx. US$307 million) and two of the undertakings’ individual revenue in the PRC exceed RMB400 million (approx. US$62 million).

MOFCOM’s clearance is mandatory regardless of whether the transaction causes or is likely to cause anti-competitive effects in the market. Under the AML, the current maximum penalty for failing to file is RMB 500,000 (approx. US$77,000) and MOFCOM may, in addition to the penalty levied, order the relevant undertakings to cease business activities and/or unwind the pre-transaction state.

The Facts

The fact patterns of the three cases were essentially similar and can be summarized as follows.

In the first case, Dade Holdings Company Limited, a BVI company specializing in the manufacture and sale of cardiovascular, obstetrics, and malignant disease medicines, was fined RMB 150,000 (approx. US$23,000) for failing to notify MOFCOM of the acquisition of a 50% shareholding of a PRC company in a similar business, with each company having a China turnover exceeding RMB 400 million (approx. US$62 million) and the combined turnover exceeding RMB 2 billion (approx. US$307 million), triggering the thresholds for notifying MOFCOM.
The second case involved the establishment of a joint venture in the PRC between a Swedish train and transportation material manufacturer, Bombardier Transportation Group Sweden Company Limited, and a PRC train and transportation technology research company, Xinyu Group Company Limited. In this case, the foreign and PRC companies were fined RMB400,000 (approx. US$62,000) and RMB300,000 (approx. US$46,000), respectively, for the same reason as in the first case. It should be noted that this was the second time in less than a year that Bombardier was fined by MOFCOM for similar infractions, with the most recent reported occasion in September 2015 (when Bombardier was fined RMB 150,000 (approx. US$23,000)). Therefore, MOFCOM more than doubled the amount of the previous penalty.
The third case involved the establishment of a joint venture in the PRC by Hitachi, a Japanese electronics and home appliances manufacturer, and Beijing CNR Investment Company Limited, a subsidiary of a large-scale Chinese train and high-speed rail equipment manufacturer. In this case, Hitachi and Beijing CNR each were fined RMB150,000 (approx. US$23,000) for essentially the same reason as in the previous cases.

Notable Points

This is already the second round of enforcement actions on fail-to-file cases published by MOFCOM in less than a year (the previous round of enforcement actions took place in September 2015). It shows that MOFCOM has been stepping up its efforts to enforce fail-to-file rules and increasing the amount of fines levied, particularly for repeat offenders. It is therefore important for companies to ensure that they consult their antitrust lawyers when planning merger and acquisition transactions or joint ventures with sizeable turnovers. Where an antitrust clearance from MOFCOM is required, it is important that such clearance be obtained before the relevant deal is closed.

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We hope you enjoyed this newsletter. Watch this space for more updates from our Asia practice.